Hatch's Senate bill aims to save state and local pensions

by Cory Eucalitto, State Budget Solutions, July 12, 2013

The federal government remains largely hands off when it comes to the management of state and local public employee pension funds. In recent years, though, there have been rumblings of some groundwork being laid for future federal bailouts of some of the most severely underfunded systems. U.S. Senator Orrin Hatch (R-UT) has drafted a bill in hopes of avoiding this fate and instead providing state and local governments an alternative to rising costs and reduced benefits. Largely by tinkering with the tax code, the proposed Secure Annuities For Employee (SAFE) Retirement Act of 2013 would overhaul the possibilities for both public and private sector employee retirement.

How it works

The portion of the bill garnering the most attention would create the option for state and municipal governments to voluntarily turn their pension plans over to life insurers and other annuity providers. It would be accomplished by giving the same preferential tax treatment afforded the money that government's set aside for pension benefits to insurance premiums.

If a plan sponsor decides to take this new route, companies would submit annual bids to provide guaranteed retirement benefits based on that year's work. By the end of a career, an employee would end up with a separate, guaranteed annuity for each year of employment. These would then be compiled together by some sort of administrative body to be delivered in the form of a monthly retirement benefit.

Intended benefits

The arrangement could offer benefits to both plan sponsors and employees. For governments, annual costs would ideally be made more consistent, although the premium itself would be subject to a collective bargaining process that today is often responsible for directly determining employee benefits.

Most importantly, pension plan risk would be immediately transferred to the companies who bid to provide annuities meaning that taxpayers would not be directly responsible for making up the difference when assets are not available to cover payments.

For employees and retirees, the actual retirement scheme itself would stay largely the same. Benefits could be made to match those provided today. Oversight would be transferred to state insurance regulators, so employees would have the same protection offered to other policyholders should their annuity provider fail to meet their obligations. Benefits would also be transferable between jobs.

Private sector changes

The bill also makes changes in the tax code related to private sector retirement benefits. It would create what is called a "Starter 401(k)" that could be offered by small and mid-size employers that do not offer a traditional defined contribution retirement package. The starter plan would allow employees to save up to $8,000 per year in an individual retirement account that would remain tax-free at the federal level. The bill would also transfer oversight of private sector 401(k) plans from the Department of Labor to the Treasury Department. This move is intended to give employers greater access to financial and other retirement advice.

Possible hang-ups

The bill already has the support of many in the insurance industry, like MetLife Inc. and the American Council of Life Insurers, for obvious reasons. The U.S. Chamber of Commerce is also on board. Yet such radical change to a sector as large as public employee retirement benefits deserves great scrutiny and close examination of possible unintended consequences.

For example, it seems that the legal basis for the protection of earned benefits would be different than today. If state insurance regulators implicitly protect benefits, what impact would another devastating economic crisis have on the system?

The legislation also bars employee contributions, instead making governments completely responsible for premiums. If premiums rise, will the possibility of employee contributions ever be placed on the table?

These and countless other questions must be answered before the country rushes into any unproven solutions. Still, the bill and its authors deserve praise for crafting innovative, federal level solutions to the state and local public pension crisis. Leaders in Washington need to recognize the very real possibility that states will one day come knocking with outstretched hands looking for money to close massive their funding gaps.

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